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Although still in its infancy, Obamacare has worked out very well so far for Michael Gregory. The 33-year-old hasn't required any special medical attention -- but his portfolio has reaped extensive benefits as the massive health-care overhaul has begun to take shape.

Gregory runs the $53 million
Highland Long/Short Healthcare
Fund (ticker: HHCAX), which has topped virtually all long/short funds both in last year's weak health-care market and this year's improved one, as well as relevant equity benchmarks. August trimmed its gains, but the three-year old Highland fund is still up 7.19% for the year through Sept. 8, topping 99% of 154 long/short equity funds. The health-care sector, meanwhile, was up less than 3%, while the Standard & Poor's 500 Index was down 4.39% for that period. For the trailing year, Highland, which invests in about 90 stocks, is up 14.60%, versus a 10.09% gain for the S&P. Over three years, the health-care vehicle is up 9.88%, better than the flat S&P. With a 5.50% load and a 1.42% expense ratio, that performance doesn't come cheaply. (Its turnover is a whopping 1,553%.) Even so, Morningstar awards Gregory's fund five stars.

"The greatest structural change to the health-care sector in 45 years will create winners and losers," says Gregory.
Pete Lacker for Barron's

The Buffalo, N.Y., native has been able to blend two long-time interests in this fund. He spent his senior undergraduate year, in 2001, at the University of Pennsylvania's Wharton School of Business, commuting to New York to work at Iroquois Capital, a long-short equity hedge fund he helped found. In 2005, he became a partner at Sands Point Partners, where he managed long/short heath-care portfolios. A year later, he launched Greenwich, Conn.-based Cummings Bay Capital, another health-care hedge fund. Highland Capital Management, a $23 billion Dallas investment firm, later bought Cummings Bay and put Gregory in charge of its long/short health fund.

He's also a health-care policy wonk. In the midst of creating Cummings Bay, Gregory picked up an M.B.A. from a specialized joint program at Yale, which brought together faculty from its medicine, management and public-health programs. Many of the instructors advise the government on health-care issues, and their debates have helped mold his strategy.

"The greatest structural change to the health-care sector in 45 years is creating a number of winners and losers," Gregory says, "which is a great opportunity for a long/short portfolio." Obamacare won't be completely in place until 2014.

He looks for companies that can contain costs, treat chronic illnesses, tap emerging markets, or help health providers do their jobs faster and better. The companies must also have defensible margins, strong free cash flow and shareholder-friendly management.

Gregory sees Merck returning 70% of free cash flow to investors via dividends, buybacks and acquisitions. He thinks it can earn $4.05 a share in 2012, topping analyst expectations of $3.84. Merck is forecast to earn $3.73 in 2011. The shares could be worth as much as 42, a far cry from their recent level near 33.

Highland CapitalManagement

Highland Long/Short Health

877-665-1287

Total Returns*

1-Yr

3-Yr

5-Yr

HHCAX

14.60%

9.88%

N/A

S&P 500

10.09%

0.00%

N/A

% Of

Top 5 Long Positions

Ticker

Portfolio**

Genesys Ventures

N/A

3.71%

Healthspring

HS

3.63%

Arthocare

ARTC

3.53%

Cigna

CI

3.30%

Achillion Pharma

ACHN

2.82%

Top 5 Short Positions

BD

BDX

-3.34%

Covance

CVD

-3.26%

Icon

ICLR

-3.15%

Quest Diagnostics

DGX

-2.90%

Luminex

LMNX

-2.89%

*All returns are as of 09/08/11; three- and five-year returns are annualized. ** As of 08/31/11. Sources: Morningstar; Russell

Another top pick is
Achillion PharmaceuticalsACHN 2.600472813238771%Achillion Pharmaceuticals Inc.U.S.: NasdaqUSD4.34
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(ACHN), even though it isn't expected to be profitable this year (it is forecast to post a loss of 69 cents a share this year and 67 cents the next). The 13-year-old New Haven biopharmaceutical outfit is developing a promising pipeline of drugs to treat hepatitis C, an inflammation of the liver that can lead to cancer or cirrhosis. Shares could trade as high as 15 over the next 12 months, says Gregory. They were recently at 6.20.

GREGORY IS WARY OF COMPANIES whose profits rely heavily on end-user demand. "We have observed a significant decrease in physician-office visits and hospital-inpatient volumes over the past several quarters and suspect that the trend is persisting," he says. Managed-care companies and insurers are getting better at rationing care. The U.S.'s budget battles are another source of concern.

Highland is short
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(BDX) on worries about its pricing power. "As the U.S. looks to implement massive cuts to health-care spending as part of the debt-ceiling legislation, hospitals are looking to reduce spending costs as a way to offset revenue reductions," he says. BD supplies hospitals with needles, syringes, integrated systems for specimen collections and cell-imaging systems. Gregory expects the shares, recently at 78.53, to trade as low as 68 over the next 12 months. He forecasts 2012 earnings per share of $6.10, below the consensus estimate of $6.21 per share. The Street puts 2011 earnings at $5.63.

The fund is also betting against
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(ICLR), an Irish contract-research organization that provides clinical-trial services to the health-care industry. In this case, he says, management has failed to adjust to the fact that such trials are shifting to Asian countries from the U.S. and Western Europe. Gregory thinks the Street's numbers in 2012 factor in a cut in the high fixed costs of the company's lab business, which has struggled over the last two years. But he doesn't think the company will meet earnings-per-share expectations of $1.20 in 2012. He believes $1 per share is more likely. The stock could trade as low as 15 over the next 12 months, down from its recent 19.14. As a result, the company doesn't look like one of the winners in the rapidly changing world of health care.